Here are the most common questions I get asked about value investing.
Historical Evidence
Studies on value investing often take on the following form:
- Sort out all the shares traded on a large exchange into groups ranked by a simple measure of value – either Price to Earnings (P/E) or Price to Book Value (P/B). The low P/E or P/B are the ‘value stocks’.
- Record the share price at the start and end of the year, add in dividends, and compare the returns of the different groups.
- Repeat the testing over many different years.
These studies have been tested across many different markets and countries and all found that the ‘value stocks’ will, on average, outperform the more highly priced “growth” stocks.
More than simply investing in low P/E stocks
While value investing strategy consists of investing in low P/E, or value stocks, the value investing process actually begins by shifting through low P/E stocks to find businesses that are truly undervalued after having a detailed look at the company and industry.
Is there greater risk?
So, if value investing out performs, you may be wondering if this is because it has taken on greater risk.
Value portfolios fall less when the market is trending down (often called a bear market). The short-term volatility or price moves closely resemble that of ‘growth’ portfolios, meaning there is no greater volatility or risk.
So why isn’t everyone using this method?
After I explain value investing, I often get asked, then, why isn’t everyone a value investor. If it works, then why isn’t everyone using it? This is usually closely followed by the concern that if everyone is using this methodology, then the price of value stocks rise and cause the outperformance to disappear.
I strongly suspect that our inherent psychological biases that I have previously covered in past blogs – including Behavioural Investing I, Behavioural Investing II and Behavioural Investing III – are the likely culprits here. Investing in a quickly rising stock tends to feel safer and provides instant gratification, even if only for the short term.
Contact arcinvest for a complimentary discussion on how a value investing approach could improve your investment returns.